The SMSF and super changes in 2020’s pipeline

This financial year so far tells us there are changes for SMSFs and superannuation more generally on the cards. Some of it is good news, but some of it will require special attention to ensure you don’t get caught out.

In brief

For SMSFs, the ATO has been more active from a compliance angle and there’s new law on non-arm’s length transactions which has stirred things up. Then we will see changes to exempt current pension income and changes to the rules for contributions which are proposed to commence from 1 July this year.

Here’s the changes, some proposals and what it means for your SMSF and super.

Non-arm’s length income could lead to higher taxes

Non-arm’s length income and taxing it at penalty rates is not new. It’s been around for many years and applies where the income and capital gains earned on the fund’s investments is greater than an arm’s length commercial rate of return.

Late last year the legislation was extended and backdated to 1 July 2018 to include situations where any net income or capital gain from an investment, after expenses, is greater than if it was made on an arm’s length commercial basis. The tax rate on non-arm’s length income is 45% and the tax continues to apply whether the investment supports the accumulation or retirement phase of the fund.

Income and realised capital gains is treated as being on a non-arm’s length basis for:

• Limited recourse borrowings which are not on a commercial basis. An example could be where the interest rate charged on the loan or the period of the loan was not in line with commercial rates. As a reference the ATO’s safe harbour guidelines for limited recourse borrowings should be consulted.
• Public and private company shares or units in a public or private trust which are not acquired at a market price. For example, the SMSF purchases shares listed on the ASX from a fund member at a substantial discount to the market price. This will result in any dividends or realised capital gains being taxed as non-arm’s length income no matter when it is received.
• Situations where services are provided to the fund at no cost or at a substantial discount. As an example, this could occur where a fund member who is an accountant and prepares the accounts using his or her business services at no cost. Another example is where a real estate agent who is a fund member arranges for the purchase or sale of a property for the fund using the services of his or her real estate company at no cost. The ATO has said that it will not be reviewing any outsourced functions to adjust for the non-arm’s length arrangements until the 2020/21 financial year. But after that, watch out.

If you think you may have a non-arm’s length income issue that dates from 1 July 2018 contact your accountant or fund administrator to see whether any amendment to the fund’s annual returns is required.

Investment strategy: ATO concerns over asset concentrations

Last year we saw the ATO write to trustees where the SMSF had a high concentration of investments in just one asset class such as property, equities, cash or fixed deposits. Our understanding is that the letters went mainly to those funds with a high concentration of investments in property.

The reaction to the ATO letters had an immediate impact and it reached further than expected. Many trustees and their advisers, irrespective of whether the fund had a high concentration, got to work trying to decipher what the ATO was after. My understanding was that the ATO’s concerns had to do with trustees not backing up the fund’s investment strategy with the reasons for their decisions.

The ATO has left it to the fund’s trustees and auditor to sort things out. If the auditor is not satisfied that the fund’s investment strategy complies with the legislation, it is up to them to provide a contravention notice to the ATO.

Greater vigilance by SMSF auditors

Court cases involving auditors over the last few years have resulted in more checking of the fund’s accounts and records. Where documents are missing or are non-existent you may find that your auditor is asking for copies of the documents or details of the relevant transaction. In some cases, the auditor may be trying to find out the level of risk associated whether a particular investment and its likelihood of recovery.

When your SMSF makes an investment, as trustee, you need to have documents prepared and available to show details of the transactions that have taken place. The earlier you provide the documents to your accountant or fund administrator the earlier the fund’s annual returns can be lodged with the ATO.

Total super balance and borrowings

Another change to the legislation passed last year and commenced from 1 July 2018 was to include any outstanding amount of any new limited recourse borrowing arrangement (LRBA) entered into from that date in a person’s total superannuation balance. However, not every fund with a new LRBA will be required to include the relevant amount for all members.

Amounts that are caught by the new legislation will include:

• Related party LRBAs where the lender is an associate of the fund. Basically, these are related party loans, and;
• Situations where a member has met a nil cashing restriction such as reaching 65, retirement, permanent incapacity or terminal medical contribution.
  

Where one of the LRBAs as described above has commenced on or after 1 July 2018, a portion of the outstanding balance of the loan is included in the relevant member’s total superannuation balance as at 30 June commencing from the 2018/19 financial year.

The importance of this change cannot be underestimated as an increased total superannuation balance may impact on:

• making non-concessional contributions to super in the following year depending on the member’s total superannuation balance;
• qualifying for catch up concessional contributions;
• using the segregated pension asset method to calculate exempt current pension income;
• work test exempt contributions in the year after a person has retired after reaching 65; 
• qualifying for the spouse tax offset, co-contribution and low-income tax superannuation tax offset.
  

Tax deductions and vacant land

In the 2018/19 Federal Budget, the government announced restrictions which remove tax deductions for vacant land from 1 July 2019 for individuals, trusts which are not widely held and to self-managed superannuation funds (SMSF). But the restrictions do not apply to companies, managed investment trusts, public unit trusts or superannuation funds other than SMSFs.

There are exceptions to the new rules which allow a deduction for expenses where the vacant land is used to carry on a business of the taxpayer, related entities of affiliates. Under the new law the costs of holding the vacant land is limited to land including any structures used in a business or are available for rent. The costs can include ongoing borrowing costs, interest incurred for loans to acquire the land, land taxes, council rates and costs of maintaining the land.

If the land that is vacant includes residential premises, a deduction for expenses will not be deductible until the premises are leased, hired or licensed or made available for these purposes.

These rules may apply to deny SMSFs a tax deduction for holding costs where the fund purchases a block of land on which a building is intended to be constructed.

Example

The Stuart Superannuation Fund which is an SMSF purchased a block of land on 31 August 2019 on which will be constructed a residential property. The building is completed and is considered suitable for occupation in November 2019 when it is advertised for rent.

Once the property is legally available to be occupied or is leased, hired or licensed then the costs of holding the land that are incurred by the SMSF will be deductible.

It is recommended that if an SMSF holds vacant land that tax advice be obtained to determine the extent to which any expenses are tax deductible to the SMSF.

Exempt current pension income (ECPI) proposals

In the 2019-20 Federal Budget, the government announced two changes to calculate a fund’s ECPI. This is where the fund’s investment income on pension assets is tax exempt because the fund is providing retirement phase pensions. If all members are in retirement phase, generally, all the fund’s investment income is exempt current pension income. But if only a proportion of the accounts are in retirement phase, only part of the fund’s investment income will be exempt.

The proposed changes announced by the government and due to take effect from 1 July 2020 are:

1. A fund in pension phase for the whole financial year will not require an actuarial certificate to claim ECPI. This proposal reinstates the previous position that existed prior to the super changes on 1 July 2017.
2. Because of the 2017 super changes, ECPI calculations for some funds became very complex. This occurred for funds that moved entirely from accumulation phase to retirement phase for part of the year and where there was also a combination of other accounts during the year.
   

From the way in which I understand the government’s proposal, the complexity will be removed, and the trustee will be provided with the option of:

• Staying with the current the current system that commenced on 1 July 2017; or
• Having the “proportionate method” apply for the whole year which is what was permitted prior to the changes in 2017.
  

The government’s proposal will be useful for those funds which use the segregated method and move wholly from accumulation phase to retirement phase during the year.

General superannuation changes

A real bonus: catch-up contributions

Since 1 July 2018 we have been able to use catch-up contributions which allows anyone with a total super balance of less than $500,000 to claim a tax deduction for any unused concessional contributions cap amount for up to 5 years. This allows you to make additional contributions in later years when it may be more affordable.

For example, let’s assume your existing concessional contributions cap for the 2018-19 financial year is $25,000 and during the 2018-19 financial year concessional contributions of $10,000 were made for you. The catch-up contribution rules would allow you to carry forward $15,000 ($25,000 - $10,000) for up to 5 years. As an example, for the 2019-20 financial year if your total super balance on 30 June 2019 was less than $500,000 you could make a concessional contribution of up to $35,000 made up of the catch-up amount of $10,000 and your standard concessional contributions cap of $25,000. The amount you could claim would also depend on other concessional contributions being made for you, such as employer Superannuation Guarantee contributions.

Although the catch-up contributions have been in operation for just one year don’t forget you have up to 5 years to use any shortfall between your concessional contributions cap, currently $25,000 and the amount of your concessional contributions for the relevant tax year.

No work test for contributions to age 67

Under the current contribution rules, you can make personal concessional and non-concessional contributions to super without restrictions prior to reaching age 65. But once you reach 65 it is not possible to make personal contributions to super with limited exceptions, unless you met certain work tests or for once off contributions such as downsizer contributions or ‘finishing work’ contributions.

The good news is that in the 2019-20 Federal Budget, the government announced the work test exemption would be extended and they would not apply until you reach age 67. The proposed change is to apply from 1 July 2020.

Finishing Work Contributions

From 1 July 2019, you are eligible to make super contributions on a once off basis if you are between 65 and 74 in the financial year after you have ceased work and your total super balance is less than $300,000 at the end of the previous financial year. This means there is no requirement to meet the work test of 40 hours in 30 consecutive days in the financial year after you have ceased work.

As an example, if you were 67, ceased working in the 2019-20 financial year and had a total super balance of less than $300,000 on 1 July 2020 you would be eligible to make super contributions during the 2020-21 financial year of up to your concessional and non-concessional contributions cap.

Super guarantee and salary sacrifice

From 1 January 2020, it is not possible for an employer to count amounts that an employee has salary sacrificed to super to satisfy against their superannuation guarantee obligation. The legislation has been amended to change the formula to work out the amount of superannuation guarantee contributions that are required to be paid and excludes any salary sacrifice amounts, but grosses up an employee’s ordinary time earnings by the amount of the amount of salary sacrificed to super.

The amended formula is:

          Employer contributions (excluding any salary sacrifice contributions)         
Ordinary Time Earnings (with any amounts salary sacrificed to super being added back)

This formula will not reduce the 9.5% superannuation guarantee contribution required to be made by an employer.

Example

As an example which compares the current calculation to the calculation from 1 January 2019, let’s consider Mary:

Mary earns $15,000 for the March 2020 quarter before any salary sacrifice to super. Her employer would be required to contribute $1,425 to superannuation to satisfy their superannuation guarantee obligation.

If Mary had salary sacrificed $1,000 to superannuation prior to 1 January 2020 in the expectation that she would increase the amount that’s going into her fund, she could be disappointed.

The reason is that Mary’s employer could count the amount she has salary sacrificed against its super guarantee obligation. This could have the effect of actually decreasing Mary’s total super contributions as the amount of super required to be paid by her employer would be based on the $14,000 salary actually paid to Mary.

Therefore the total contribution for super guarantee purposes is now $1,330 which is made up of Mary’s salary sacrifice contribution of $1,000 plus a top up of $330 from her employer to meet the super guarantee liability.

Redundancy and early retirement scheme concessions

The age at which someone can access the tax-free amount of a genuine redundancy and early retirement scheme payment has been increased from age 65 to 67 to link it to changes in the Centrelink Age Pension age. For the 2019-20 financial year the service-based tax-free amount is $10,638 plus $5,320 for each completed year of service with the employer.

The May 2020-21 Federal Budget

The May 2020-21 Federal Budget is scheduled for the second Tuesday in May which is 12 May this year. Submissions are currently being made to the government and close on 31 January. Whatever is finally announced on Budget night, I think you can be reasonably certain there will be something about super and retirement.